Gem Diamonds' (LON:GEMD) Returns Have Hit A Wall

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Gem Diamonds (LON:GEMD) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Gem Diamonds, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.093 = US$32m ÷ (US$366m - US$23m) (Based on the trailing twelve months to December 2022).

Thus, Gem Diamonds has an ROCE of 9.3%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 13%.

Check out our latest analysis for Gem Diamonds

Above you can see how the current ROCE for Gem Diamonds compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Gem Diamonds here for free.

The Trend Of ROCE

Things have been pretty stable at Gem Diamonds, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Gem Diamonds to be a multi-bagger going forward.

The Bottom Line

We can conclude that in regards to Gem Diamonds' returns on capital employed and the trends, there isn't much change to report on. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 78% in the last five years. Therefore based on the analysis done in this article, we don't think Gem Diamonds has the makings of a multi-bagger.

Gem Diamonds does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.